Monday, February 02, 2009

What Won't Be Changing

February 2, 2009

Government policy adjustments are feedback loops which will affect small systems, but they are incapable of changing the major trends.

Amidst the debate about whether the "stimulus" and "bad bank" plans will magically restore the U.S. and thus the global economy to what once passed for "health," it's good to recall what can't and won't be changed by any government policy adjustments.

1. Demographics. The entire model of retirement and healthcare for the elderly is based on the shorter lifespans, low-cost medical treatments and robust worker-retiree ratios of the 1940s.

That model no longer has any relation to reality. The majority of people will live almost a full generation longer than their great grandparents, meaning many will be drawing benefits nearly as long as they worked.

The worker-retiree ratio has fallen from 10-to-1 to 2.5-to-1--clearly, unsustainable. In nations with low birthrates, it will soon fall to 1-to-1.

A standard heart surgery and recovery now costs more than most homes. Forty years ago it did not cost 5 years' wages to enter the hospital for a few days and undergo a procedure. Now it's "normal."

This is all unsustainable/unaffordable, and no amount of tweaking the edges will change that.

And so then what? Without a rapid reflation of these assets into new bubbles, then nobody has any new equity to borrow against, and thus the economy flounders. Recall that the entire "prosperity" of the past 8 years--and to some degree, of the past 25 years-- was based on rising assets and massive borrowing by all players: government, business and consumers.

Without rapid growth in asset valuations, then there's no new equity to borrow against. The economy stagnates.

Homeowners and businesses extracted trillions from their rising equity/valuations in the past decade; that boom is over and will not return.

If your house stabilizes in value, you may well breathe a sigh of relief--but that alone isn't going to enable you to borrow more money and go on a consumer-spending binge.

Then there's the deleveraging. As governments sort through the wreckage, they are already tightening the screws on leverage. The global assets bubbles were enabled by leverages of 40-to-1 or even higher and the sales of derivatives with murky underlying value.

Once leverage is throttled back and assets return to historical norms, there is simply no way debt can explode to the levels necessary to fund a global burst of debt-based spending. In simple terms: the leverage, borrow and spend game is over, never to return in our lifetimes.

3. The U.S. economy remains top-heavy and high-cost. The only way any society can pay 5 years' wages for a few days in the hospital and 10 years' wages for simple homes is via leverage and stupendous borrowing. Once these items must be paid with savings/cash then the entire cost structure implodes.

Only when it does implode in a nationwide insolvency will cost structures in all industries fall to sustainable levels.

Here's one example. Houses that "cost" $400,000 have to be rented for $3,000 a month for the owner to cover the costs. The renter has to make $6,000 a month to pay this inflated rent.

Say the house falls to $50,000. The owner can then rent it profitably for $500 a month (unless they're still paying high property taxes.) The renter only needs to make $1,000 to rent the house. The entire cost structure has shifted down.

4. The "head-fake" in energy costs (down) will eviscerate the "financial" reasons to invest in alternative energy. This guarantees that when we need alternative energy in scale, it won't exist because it didn't make financial sense until the price of fossil fuels has already made quantum leaps. And since price can leap in a few months while new production takes years, it's easy to foresee a "crunch time" when energy prices explode and production lags demand for years.

Already we've seen biofuels outfits going bankrupt and dozens if not hundreds of petroleum and other energy projects put on hold as oil fell from over $100 to under $40/barrel. As oil exporting nations (recall that the private "oil majors" like Exxon and Chevron control only 3% of the world's oil reserves) pump every barrel they can to fund their welfare states (lest they be deposed by social unrest), the price of energy will stay low until the sagging global production finally falls below declining consumption.

When that happens, prices will turn upward on a dime, while production, which takes years and billions in investment to increase, will be standing still. That's how you get gasoline/diesel/jet fuel shortages and $300/barrel oil.

Yes, it is shortsighted in the extreme to expect oil to stay at $40/barrel, or even $30. It might even test its old lows at around $12/barrel. Financially, it makes no sense to pursue alternatives which cost $60-$80/barrel until oil rises back to $80/barrel.

But ironically, once it does jump back to $80/barrel, then there's nothing to stop it from going to $100, $200 and $300/barrel if production has been crippled by lack of investment.

5. The cost of borrowing is about to rise--and will continue rising for a generation. The global debt-based "boom" created the illusion of a "savings glut" in which trillions of dollars were sloshing around the world looking for a safe return.

Yet even as governments around the world are trying to sell trillions in new bonds/debt to fund their stimulus/bailout schemes, the deleveraging of global finance and the crash of bubble-era asset valuations and oil ensures that there is no longer a massive surplus of capital (or borrowed money) floating around looking for a home.

If anything, the big lenders of the past--the Gulf oil exporters and the Asian exporters--are now needing to spend their remaining capital on their own restive populations.

The debt train is speeding through the fog of "stimulus" and "bad banks" toward the stone wall of "no more trillions available to borrow."

6. Americans still won't need all the non-essential consumer stuff and services they bought during the debt-frenzy bubble. Here is an example: one of my dopplegangers (i.e. he too is "Chuck Smith"--Charley, Charles, Chuck, same difference) in Texas was recently laid off from his $90,000 a year job: A Layoff in the Smith Family Ripples Through Town (WSJ)Read the piece and then ponder how a typical high-wage earning U.S. family managed to burn through $180,000 a year in salaries--no, not a big mortgage--and end up with $25,000 in credit card debt.

Stuff the Smiths (and all other Americans) no longer need and will never "need" again:

12. storage facilities for all the crap they already bought and can live without: snowboards, extra furniture, bikes nobody rides, old TVs, computers, etc.

When all this junk gets emptied out of 10 million storage lockers, the national garage sale will be one for the ages.

Some readers tell me once this happens, then we'll face shortages of goods. I am skeptical of this happening soon because cars, computers, snowboards, bicycles and even shoes and clothing last a long time if cared for. My car (Honda Civic) is 10 years old and will easily last another 10. My good clothing is years old and still like new. My bicycle (Mongoose) has logged thousands of miles and it still good for thousands more (never mind the sticky derailleur). Ditto my wife's Specialized bike (both bought used). Our cheap Compaq PCs may well last for years longer. Our Mac is 10 years old and still works fine for most computer tasks. All of these are typical name-brand items millions own.

Our tools are decades old and in no danger of breaking. Ditto our dishes, silverware, furniture, pots and pans and 99% of the items we use daily. Maybe our old Sony TV will break down in a few years, but maybe not. Maybe it will last another 10 years, too.

Shortage of goods? Maybe in 5 years for a few things, maybe 10 for others. Maybe repair will come back in style for financial reasons. In the meantime, there will be no shortage of export-model nations still seeking to dump goods in the U.S. for the simple reason they have no domestic demand or any Plan B. Export or die is the model, and despite numerous hollow claims about fostering domestic demand, nothing else has worked.

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